Canada Agency Says Finance Safe Amid Expansion: Mortgages

By Andrew Mayeda and Greg Quinn -
Mar 9, 2012

The Canadian housing agency’s
vulnerability to mortgage defaults has soared nine-fold in 20
years, approaching levels reached by Fannie Mae and Freddie Mac
in the U.S. at the height of the housing boom. Canada Mortgage &
Housing Corp. says its finances are secure unless the country
plunges into deep recession for several years.

Government-owned CMHC insured C$541 billion ($546 billion)
in mortgages as of Sept. 30, an amount equal to 31 percent of
Canada’s annual gross domestic output, as home prices climb and
construction expands. In 2006, when U.S. home prices peaked, the
combined exposure of the government-backed agencies to potential
defaults was slightly more than a third the size of the economy,
according to Bloomberg calculations based on U.S. Federal
Reserve data. Fannie and Freddie were bailed out in 2008.

“If a significant number of homeowners default, CMHC would
have a lot of claims they would have to pay out,” said John
Andrew, real-estate professor at Queen’s University in Kingston,
Ontario. Homes would “sell at greatly discounted prices as
supply exceeds demand,” he said, adding “the risk of this is
significant.”

CMHC has enough capital to remain solvent unless Canada
were to see “multi-year recessionary periods” with
“persistent high unemployment going above 13 percent” and
house prices falling close to 25 percent, the agency said in an
e-mailed response to Bloomberg News. Canada hasn’t approached
CMHC’S worst-case scenario since 1982, when unemployment peaked
at 13.1 percent in December at the end of a six-quarter
recession.

Not Losing Sleep

“You can’t rule out the possibility of a significant
correction in Canadian real estate because there is
overvalution, but I just don’t see the catalyst to cause it to
happen in the near term,” said Craig Alexander, chief economist
of Toronto-Dominion Bank. (TD) “I’m not losing any sleep over the
taxpayer liability of CMHC insurance.”

Canadian home sales accelerated in February on an annual
basis, regional data show, adding to evidence the country’s
housing market remains buoyant amid low mortgage rates.

Canadian housing prices have increased 44 percent since
2006, while U.S. prices have fallen 32 percent. Finance Minister
Jim Flaherty, who has acted to try to cool the market three
times since 2008, warned again this week that families should be
careful about taking on debts they won’t be able to afford when
interest rates rise.

Greatest Domestic Threat

The Bank of Canada, which has kept the country’s benchmark
interest rate at 1 percent since September 2010, reiterated
yesterday record household debts represent the greatest domestic
threat to the country’s economic outlook. The central bank
forecasts consumption and housing will account for more than
half of the country’s 2 percent economic growth this year, after
such spending helped lead the economy out of a recession in 2009
ahead of other Group of Seven nations.

CMHC’s estimate of its ability to stay solvent is based on
stress tests it conducted last year using 10,000 economic
scenarios. The probability of insolvency is less than 0.5
percent, the agency said. An increase in unemployment and
decrease in housing prices would be the main driver of insurance
claims against CMHC, followed “much further down” by an
increase in interest rates, Serre said.

Chances of Correction

Another 1980s-style housing correction can’t be ruled out,
said Finn Poschmann, vice president of research at the Toronto-
based think-tank C.D. Howe Institute. “Everything under the sun
will happen again. It always does,” Poschmann said, adding
CMHC’s stress tests would be more credible if the agency
provided enough data for outsiders to validate the results.

There’s a 15 percent chance housing prices will decline 10
percent or more over the next year, according to the median of a
Bloomberg survey of 13 economists last month. CMHC said in a
Feb. 13 report the average price of existing homes will climb
2.7 percent in 2013.

“Although there were a lot of discussions in the public
domain about a house-price bubble, I must say clear evidence is
lacking to support those conclusions,” said Mathieu Laberge,
CMHC’s deputy chief economist, in a telephone interview.

Unlike the U.S., Canada avoided having to directly inject
public money into the country’s financial institutions during
the financial crisis. In September 2008, the U.S. took control
of Fannie Mae and Freddie Mac, which have since received more
than $180 billion in government funds. Freddie Mac said today it
will ask for $146 million more in aid to cover its deficit at
the end of last year.

Growing Balance Sheet

As Canada’s housing market has boomed, CMHC’s balance sheet
has grown to record levels. In 1982, CMHC insured C$29.1 billion
of mortgages, equal to 7.7 percent of the country’s output, less
than one-quarter of today’s proportion. The agency’s total
assets have increased from C$8.9 billion in 1991 to C$294
billion at the end of September.

This growth has put CMHC under greater scrutiny. In a
December report, International Monetary Fund staff called on the
federal government to review the agency’s governance and
oversight, and assess whether the agency needs to do more to
protect itself against housing market risks.

CMHC was established in 1946 to address a housing shortage
at the end of the Second World War. It began insuring mortgages
in 1954, the agency says, partly to encourage private lenders to
play a bigger role in mortgage underwriting.

Rise in Claims

In the late 1970s, claims on CMHC insurance rose sharply
following losses on programs to insure homes and rental units
for low-income individuals. The rise in claims created a C$786
million actuarial deficit in the agency’s insurance fund by
1984, a hole it filled partly by borrowing from the government.

By insuring mortgages against default, CMHC says it helps
lenders keep mortgage rates low. The agency also buys mortgage-
backed securities from financial institutions, which it says
lowers funding costs for banks and other lenders.

In Canada, federally regulated financial institutions must
obtain insurance on mortgages where the downpayment is less than
20 percent of the purchase price. While CMHC insures these
loans, 73 percent of its coverage is on mortgages that have
loan-to-value ratios of less than 80 percent, which are often
securitized by Canada’s largest banks.

Canada Mortgage Bonds

Since 2001, CMHC has funded its purchases of mortgage-
backed securities by issuing Canada Mortgage Bonds, which are
backed by the Canadian government and share its top credit
rating. CMHC issued more bonds last year than any provincial
government, according to data compiled by Bloomberg. The
agency’s guarantees on Canada Mortgage Bonds and mortgage-backed
securities have risen to C$334 billion from C$8.4 billion in
1991.

Bonds issued by Canada Housing Trust, CMHC’s financing arm,
have lost 0.3 percent this year through yesterday, according to
Bank of America Merrill Lynch data. That compares with losses of
0.4 percent for federal government bonds, and gains of 0.9
percent for global government bonds. Housing Trust bonds made 6
percent last year, versus 9.6 percent for Canadian governments
and 6.1 percent for global sovereign debt.

The Office of the Superintendent of Financial Institutions
(OSFI), the country’s banking regulator, doesn’t formally
oversee CMHC. Still, the agency says it holds more than twice
the level of capital OSFI requires private mortgage insurers to
hold.

Few AAA Sovereigns

“If you look at Canada’s ability to pay relative to most
of its peers in the G-7 and the rest of the world, it’s pretty
darn good,” said Marc Rouleau, Montreal-based vice president of
fixed income at Standard Life Investments, which manages C$31.5
billion in assets in Canada. “Canada’s one of the few remaining
sovereign AAAs out there.”

CMHC points to several differences between the U.S. and
Canadian home-finance systems. The “subprime” loan market
didn’t take hold in Canada like it did in the U.S., the agency
says, and so it isn’t exposed to such risky loans, as Fannie Mae
and Freddie Mac were.

Fannie Mae and Freddie Mac are government-controlled
companies that buy mortgages and repackage them as bonds.
Pressure to enhance short-term returns for shareholders was one
of the factors that led Fannie and Freddie to buy risky
mortgages, according to a panel set up by Congress to look into
the causes of the crisis.

Government-Owned

While CMHC also holds mortgage-backed securities, its main
business is insuring home loans against the risk of default.
CMHC is fully owned by the federal government.

Amid concerns about the country’s housing market, Flaherty
may be preparing to further rein in CMHC. In his budget last
year, Flaherty gave himself the authority to charge CMHC to
compensate for the risks posed by its insurance book.

The government may also soon need to decide whether to
raise the C$600-billion limit CMHC has on the amount of mortgage
insurance it is allowed to issue. The corporation said Jan. 31
it has been rationing insurance for lenders.

“We think we’re going to be able manage within the
limit,” Serre said.

CMHC reports to the country’s Parliament through Human
Resources Minister Diane Finley. A spokeswoman for Finley,
Alyson Queen, said CMHC is operating within its insurance
limits, and declined to comment on the agency’s risk management
and oversight.